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Depositors' interests must be paramount

Oct 21, 2013

The Reserve Bank of India (RBI) Governor, Raghuram Rajan, will, on October 29, 2013, unfurl the Second Quarter Monetary Policy Review for 2013-14. Governor Rajan has demonstrably shown that he leads from the front, with hands on the nuts and bolts of policy and operations. While the policy will be formulated against the backdrop of numerous constraints, both domestic and global, the common person can rightfully hope that Governor Rajan will also pay attention to the woes of small savers.

RBI's balancing act

More than four decades ago, the then RBI Governor, the late L K Jha, would have said that someone (government) has jammed the accelerator and it is the job of someone else (RBI) to slam the brakes. In this process, he saw his task as ensuring the lowest possible interest rate for borrowers, while rewarding depositors with the highest possible interest rate. In recent years, however, depositors have been brazenly shortchanged. The government has been overtly championing the cause of borrowers, who want lower and lower interest rates on loans, notwithstanding that inflation is eroding the real rate of return to depositors.

Impact of inflation

The latest Consumer Price Index (CPI) for September 2013 shows a year-on-year inflation rate of 9.84 per cent, which would imply that, in real terms, the RBI is providing accommodation to banks at negative real rates of interest. Moreover, depositors are getting negative rates of interest. It is well-known that official price indices, the world over, understate the 'true' rate of inflation, which, in the present situation in India, could imply a 'true' inflation rate of 14-15 per cent per annum. In this context, depositors will fervently hope that Governor Rajan will give paramount importance to the interests of depositors.

The inadequate rate of return has resulted in a drop in household sector savings in financial assets from 12.0 per cent of the GDP in 2009-10, to 8.0 per cent in 2011-12. During the same period, household sector savings in physical assets rose from 13.2 per cent to 14.3 per cent. This unmistakably shows that to the extent savers have choices, they are moving away from financial savings to physical savings. Punishing savers is a dangerous path for policy to take and one hopes that Governor Rajan will roll back these imprudent policies.

RBI policy signals

RBI needs to raise the policy signalling repo rate (i.e. the rate at which banks borrow from the RBI against the collateral of government securities, subject to a quota). A strong signal in the October 29, 2013, policy would be if Governor Rajan raises the repo rate from 7.5 per cent to 8.0 per cent. At the same time, the interest rate on the Marginal Standing Facility (MSF), at which banks borrow from RBI above the quota, should be maintained at the present level of 9.0 per cent. Over time, the RBI should ensure that the repo rate is somewhere between the banks' one year deposit rate (most banks offer 8.5-9.0 per cent) and the base lending rate (9.8-10.25 per cent). Large industry would no doubt howl, but as Governor Rajan puts it, he is not in the game of looking for Facebook 'likes' and that he would do what is in the best interests of the country as a whole.

Allocation of credit

There have been considerable noises, backed by government, that export credit should be included in the priority sector. The institutional memory of the government and RBI should certainly recall that this is an old issue. Including exports in the priority sector would crowd out other legitimate demands of small and weak borrowers. Moreover, export credit has the unique advantage of it being linked to export refinance. This suggestion should simply be tossed out.

Financial inclusion

The Nachiket Mor Committee is looking into the issue of how to make financial inclusion really effective and not merely a slogan to be soon forgotten. The All India Rural Credit Survey Committee of Direction, in its Report in the 1950s, acknowledged the world over as a pioneering work - had poignantly said that the authorities periodically wake up to the problems of rural credit, whenever there is a crisis, but soon forget all about it once the crisis has passed. Over the past 60 years we have had the Community Development Project, the Package Programme, the Integrated Rural Development Programme, the Twenty-Point Programme, the Service Area Approach and of course, now, financial inclusion. Financial inclusion cannot be effective in a vacuum; there has to be some real sector activity which can be supported by the financial sector.

Cartelisation of the savings bank deposit rate

While the RBI would no doubt wish to wait for the Nachiket Mor Report, there is one issue relating to the savings bank deposit rate, which needs urgent attention.

In remote rural areas, the first contact a customer has with banks is through the opening of a savings bank account. As part of the financial liberalisation, term deposit rates were freed in the mid 1990s and each bank now fixes its own structure of term deposit rates. Since the mid-1990s, the deregulation of the savings bank deposit rate has been debated extensively. The major banks have made shrill noises that deregulation of the savings bank deposit rate will result in chaos. It was further argued that banks now have sweeping accounts, where holders of savings bank accounts can arrange to have automatic sweeping out of excess balances and automatically replenish the savings bank account whenever it falls below a predetermined minimum figure. Again, in term deposits, there are multiple option deposits, which provide ready liquidity to term deposit holders. It is argued that if small savers, particularly in rural areas, do not use these facilities, it is their own fault- such thinking is elitist and cannot be countenanced.

In November 2011, Governor Subbarao took a momentous decision to deregulate the savings bank deposit rate and each bank was free to set its own interest rate. While a few small private sector banks have set their own rate, all the public sector banks, the large private sector banks and foreign banks, operating like an informal cartel. have uniformly fixed the savings bank deposit rate at 4.0 per cent, the erstwhile regulated rate. Banks with a low proportion of current and savings bank accounts (CASA) would largely benefit by raising their savings bank rate. The question is whether there is a cabal of a few large banks with high CASAs putting the fear of God of retaliation if any large bank, particularly in the public sector, breaks rank and independently fixes its own savings bank rate. RBI needs to use suasion on October 29, 2013, to reiterate the spirit of its November 2011 deregulation and urge banks not to resort to an informal cartel. Sooner or later, the Competition Commission and, or, the courts would intervene and the banks will have egg on their faces. Hopefully the Nachiket Mor Committee will also focus on this important issue.

Please Note: This article was first published in The Freepress Journal on October 21, 2013. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

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